Op-Ed

When 'innovation' means rule-breaking

There is a simple reason the drug trade is so lucrative: Government mandates create a market opportunity for businesses willing to shirk the law.

In the technology and venture capital world, this principle has not gone unnoticed. Some of the highest profile recent start-ups were built to exploit unmet consumer demand created by regulatory restrictions. Uber and Airbnb, for instance, have prospered because taxis are hard to find, and hotels are expensive and heavily taxed, while there are plenty of ordinary people with extra automobile capacity and rooms to rent.

As technology know-how becomes less expensive and more pervasive, some start-ups “innovate” not by improving platforms or back-end design, but by ignoring regulations that govern the existing market in pursuit of growth. Established firms can't assume this sort of legal risk — they have too much to lose. Venture capital firms, however, can make calculated bets on breaking the rules.

They can develop comparatively uncontested “gray markets” by funding firms that operate in an unclear legal limbo, or simply declare that existing laws do not apply to these start-ups because their products, services and business models are new.

Gray market firms typically adopt a distinctly libertarian posture, advocating trust in business and promoting the idea that all innovation is good. This is definitively false. Not all innovation is socially responsible or beneficial. And simply ignoring legislated labor, licensing, consumer protection and advertising policies — as Uber has been accused of doing in California and elsewhere — threatens to undermine government's ability to address issues of public interest such as health, environmental impact, privacy, safety and competition.

Nor is it true, as some gray market firms and their investors would have us believe, that
regulation necessarily stifles innovation.

The music service Napster was one of the first sharing firms of the Internet era and provided a test case. As much as the public may not like copyright laws, they were deemed to apply. Yet Napster's legal take-down did not signal an end to disruption. Apple, Spotify, Amazon and others have found ways to work within the existing system to change how music is consumed.

Conflict between innovators and the existing world order is nothing new. The automobile of the early 1900s faced as much legal head wind as drones do today. Attempts to regulate automobiles through vehicle registration, driver's licensing and speed limit ordinances were considered by manufacturers to be prejudiced against the industry. Henry Ford sued the city of Detroit, claiming that automobiles were unfairly singled out vis-a-vis horse drawn carriages. But resistance gave way to cooperation as manufacturers realized that regulation could help consumer confidence by promoting safety. Governments and automobile associations ultimately worked together to fix gaps in the legal framework.

More recently, Netflix took an active role in shaping regulation around net neutrality, codifying open access to bandwidth. Since Netflix uses more than one-third of all Internet bandwidth in the U.S., net neutrality is as crucial to its business model as the open roads were to Ford.

The many legal battles of companies such as Uber are not about whether the sharing economy has merit (it does) or whether the regulations that protect older, traditional companies benefit consumers (some of them do not). They are really about whether start-ups should have limits to their rights, just like the rest of us.

The Trans-Pacific Partnership trade agreement may magnify this issue. The draft agreement, leaked online, includes Investor-State Dispute Settlement rules that allow businesses to sue governments if they believe their rights to operate are in conflict with regulation. In effect, this will create a world dominated by gray market thinking.

Democratic governments make rules for all sorts of reasons, and many do not operate as intended, or even benefit the public. But whether it is regulating the sale of tobacco products or requiring drivers to obtain a license before transporting others, we should consider carefully whether we want to abandon our system of government oversight in favor of short-term business gains, the markets and granting unfettered freedom to operate for whatever innovation comes along next.

California in particular has historically taken an active regulatory role in commerce — on a variety of issues including emissions and domestic partner benefits. Companies complain, companies comply and our state thrives. Sharing-economy firms should be able to compete without thinking that they are somehow immune from the rules.

Dave Rochlin is a lecturer at UC Berkeley's Haas School of Business, and is the executive director of the University's Applied Innovation programs and Innovation Roundtable.

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